Risk pull-back

Oil is down 7% today. Gas is down 6%. Silver is down almost 9%. Rates are about 3 bps lower. Stocks are down 50 bps.

Something is happening in commodities. There are certainly reasons to be bearish. Prices are extremely high. Inventories are generally above their long-term average. Demand is pulling back. Most recent economic news has disappointed- from NFPs to ISM to GDP growth. So a pull-back is justified, but the change in commodities is far more extreme than the de-risking that is occurring in rates and equities. Why is that?

Bill Gross' new investment outlook reiterates his short treasuries thesis, this time relying on evidence from a recent paper by Carmen Reinhart and M. Belen Sbrancia. This paper describes how governments delever by setting treasury yields below real interest rates. It's a fascinating study and a valuable perspective. The last time the US faced an indebtedness comparable to today was during World War II, when total debt exceeded 100% of GDP. It's often assumed that we overcame the massive fiscal debt through 2 decades of substantial growth. But Gross, Reinhart, and Sbrancia remind us that yields on government debt were below real interest rates post WWII, thus effectively deleveraging the balance sheet over time. I've mentioned before the role of the Fed in supporting the government bond market during and after WWI and WWII. Milton Friedman describes the conflict between the Treasury and Fed after WWII, as the Treasury effectively forced the Fed to keep yields low for almost a decade after the end of the war (see Monetary History of the United States).

If Gross is correct and we are living in a world of negative real interest rates for savers, what is the outlook for inflation? Today's move in commodities says a lot. When the government is effectively deleveraging by keeping government debt yields below real interest rates, economic growth becomes the difference between hyperinflation and something more normal. That leaves commodities as the asset class the most leveraged to economic growth. As Gross points out, holders of Treasuries will get burned as yields stay below real rates. But with weaker growth than expected, commodities will no longer capture the yield being stolen by the Fed.